Tutorial 4

Section A: MCQ
1. C
2. C
3. D
4. C
5. B
6. A
7. B
8. B
9. B
10. A

Section B: Essay Question

1. Define inflation and show how it is measured. (4 marks)

Inflation is a persistent rising general level of prices. The inflation rate is the
percentage change in the price index from the preceding period. We use the CPI to
compute the inflation rate.

CPI ∈ year 2−CPI ∈ year 1

Inflation rate in year 2= x 100
CPI ∈ year 1

2. (a) Briefly describe the Rule of 70. (3 marks)

- Rule of 70 is to calculate how long it would take for a given rate of

inflation to double.
- 70 is divided by a given annual rate of inflation.
- For example, if annual rate of inflation is 3%, the price level will take
70
about 23 years to double because 3 = 23.33 years.

(b) Who is hurt by unanticipated inflation? Describe any TWO (2) examples. (5 marks)

Unanticipated inflation hurts fixed-income receivers, savers and creditors (lenders). It

redistributes real income away from them and towards others.

 Fixed-income receivers
People whose income are fixed see their real incomes fall when inflation occurs such
as pensioners because the purchasing power of the income will be less as inflation
continues to deflate the value of the dollar.

 Savers
Value of savings decline if the rate of inflation exceeds the rate of interest.
For example, a family buys a a new home with an adjustable-rate mortgage that is
above the rate of inflation will be hurt because the amount they pay each month will
increase as inflation increases.
3. Identify any TWO (2) groups of people who are hurt by inflation and any TWO (2)
groups of people who benefit from inflation. (4 marks)

 Two groups of people who are hurt by inflation are:

Fixed income receivers
- Fixed income receivers are the people whose incomes are fixed and see their real
incomes decrease when inflation occurs. For example, the people who are retires will
purchase fewer goods and services if the price increases.

Savers
- Savers is a value of savings decline if the rate of inflation exceeds the rate of
interest. For example, if Max saves Rm1000 in a bank with 6% interest rate (i) per
annum and π (inflation rate) = 13%. Although the saver will receive RM1060, at the
end of the year deflating RM1060 for 13% inflation means that its real value is only
RM938.
RM938 = RM1060 / 113 x 100

 Two groups of people who benefit from inflation are:

Fixed income receivers
- Flexible-income receivers are people who have flexible income that may escape
inflation’s harm or even benefit from it. For example, social security or part-timer.
They receive current payments.

Cost of living adjustments (COLAs)

- Cost of living adjustments is some union workers get automatic cost of living
adjustments in their pay as the CPI increases. For example, Ali and Abu know the
inflation coming soon, they will begin to get higher wages to prevent erosion of
benefits from inflation.

4. Distinguish between demand-pull inflation and cost-push inflation. (5 marks)

Demand-pull inflation caused by an excess of total spending beyond the economy’s

capacity to produce. When additional supply is unavailable, sellers raise their prices.

Cost-push inflation caused by rising per-unit production costs. It’s came from supply
side inflation. For example, a supply shocks could abrupt increases in costs of raw
materials drive up per-unit production costs and thus product prices increase.

Wage-push as a result of union strength costs increase due to increases in wages.

5. Briefly explain the following concepts:

(i) Consumer Price Index (CPI) (2 marks)

- A widely cited index number for the price level; the weighted average of prices of a
specific set of goods and services purchased by a typical household.

- Consumer index price (CPI) is the measure of the overall cost of goods and services
that bought by a typical consumer.

(ii) Base year (2 marks)

Base year is the year chosen as a point of reference or basis of comparison for prices
in other years; a benchmark year. Actually the price level on the base year, they don’t
have any add on the inflation rate value.

6.
Total expenditure in 2012 RM750 billion
Total expenditure in 2005 RM250 billion
Based on the data above:
(i) Calculate the Consumer Price Index in 2012 assuming 2005 is the base year.(4 marks)

Total RM expenditure ∈2012

CPI = x 100
Total RM expenditure ∈2005
RM 750 billion
= x 100
RM 250 billion
= RM 300 billion

(ii) Calculate the inflation rate for 2013, assuming the Consumer Price Index for that
year is 330. (4 marks)

Given that CPI 2012 = 300, CPI 2013 = 300

CPI ∈ year 2−CPI ∈ year 1 x 100

Inflation rate for 2013 =
CPI ∈ year 1
330− 300 x 100
=
300
= 10%